Multifamily properties can be a solid investment and a great addition to any portfolio. Benefits range from more reliable income than you’d get from a single-family to a lower price per unit than one-family properties provide.
All advantages aside, when you’re considering multifamily properties—especially those with more than five units—you have to be careful when it comes to where you’re investing. The state of your investment and your return is where you need to focus your attention, and that’s usually something you can forecast by examining the seller’s financials.
How to value a multi-unit property
When you’re looking at a single-family property, the value is determined by the appraiser looking at recent sales of similar properties in the same area. When you value a multifamily property, the return of investment the owner receives is front and center. It’s difficult to find multi-units in the same area with the same features, so the money the seller is making off that property is largely what determines its value.
The value of a multifamily property can be changed internally by the seller raising rents or lowering expenses.
It’s vital you know how to correctly value a multi-unit property so you don’t overpay, which can prevent you from achieving a profitable cash flow.
Value determination: the basics
As you’re reviewing the seller’s financials, keep the basics of value determination for multi-unit properties as follows in your mind:
- Income: all the revenue the property generates
- Expenses: all the property’s expenses other than capital expenditures and debt service
- Net operating income: the income minus the expenses
- Debt service: mortgages and other loans covered the property
- Cash after debt service: the net operating income minus the mortgage or other debt service
The net operating income is your biggest concern. The goal of a successful multi-unit property owner is to improve the NOI by decreasing expenses and bumping up revenue. The higher the NOI, the more cash that will be available after the mortgage is paid.
Still, you want to look at all aspects of the seller’s current financial picture so you have a reasonable idea of what you’re getting and what you’re not with the property you’re thinking about investing in. Check if the seller is carrying a lot of monthly expenses that eat into his or her profit flow and if so, find out why.
Carefully reviewing and assessing the seller’s financial picture before you invest in a multifamily property can save you some unpleasant surprises and help shape realistic expectations before you buy. Always insist on a full financial disclosure from a multi-unit seller!
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